How to improve your RIA valuation in this — or any — market

Mergers and acquisition activity in the RIA industry has been extremely high compared to recent years, according to DeVoe & Co.'s RIA Deal Book. The heightened volume of deals over a short period of time indicates that the rules have become more nuanced when it comes to capturing a higher valuation for your firm.

But regardless of where this trend is heading, and whether you are soliciting offers now or plan to do so three, 10 or 20 years from now, growth-minded RIAs need to understand the metrics that always matter when it comes to amplifying valuations — and build accordingly. 

Elements

If you are a growth-oriented RIA, your earnings before interest, taxes, depreciation and amortization (EBITDA) will get a nice boost during the appraisal process. The buyer will include "add-backs" — a favorable EBITDA adjustment — on the assumption they can consolidate overhead costs upon acquisition. While there's usually a diminishing advantage for firms that run operating margins above 50%, add-backs will boost EBITDA for typical firms by 15% to 20%.

Buyers are also savvy enough to recognize incremental growth spend and give you credit for more add-backs. If you've recently put money behind a new subscription service, online course, website or partnership program, for instance, you'll be able to earmark those expenses and write them off as "test-and-learn investments" or "future revenue streams." Also, when the buyer pendulum swings from the heights of confidence into the realms of caution, they'll want more assurance that your firm will keep growing after the sale. And while past performance does not always guarantee future results (thank you, compliance department!) you can bet they'll be looking for a consistent track record of organic growth much more closely than your current profitability. 

Keep in mind that offers typically include a generous post-sale earnout incentive, which is tied to top-line performance (i.e., a three-year compound annual growth rate — CAGR — hurdle). If your firm hasn't created momentum for future growth because you've been more focused on the bottom line, you'll have difficulty flipping the switch on your growth engine for the earnout period.

So how will buyers measure your organic growth?

Organic growth rate is usually calculated by dividing your annual net asset inflows by your total assets under management (new client transfers + existing client deposits - existing client withdrawals - lost client transfers divided by total AUM). In other words, how fast does your firm accumulate assets without help or harm from the markets? 

According to the CFO we know at a large and actively acquiring RIA, performance benchmarks for organic growth — using the equation above — are as follows: 

1%-3% = typical; 6%-7% = high; 10%+ = very high

How does your firm stack up?

Younger clients provide organic growth 
For an enduring way to improve organic growth, shift your attention to the mid-career accumulator. The allure of large AUM cases, which provide an immediate shot in the arm, understandably points a lot of firms toward retiring professionals who have already banked sizable investment accounts. 

Great — let's keep that revenue stream going! But let's also start adding more mid-career professionals to the portfolio. They're earning, they're saving and, unlike a book composed of 70-year-old clients, the more of them you have, the more you'll see the "existing client deposits" part of your equation start to compound.

READ MORE: Despite 237% M&A surge, half of deals go up in smoke, Fidelity says

It's also worth noting that buyers are enticed by a "younger" clientele because they represent higher lifetime values with decades of future revenue ahead. 

Based on the above, this formula involves:

• A flexible pricing model to subsidize lower AUM cases with monthly planning fees
• Processes that focus on helping busy professionals organize their chaotic lives
• Advice that addresses the overlap between personal and business finance
• Benchmarking to show how they are doing compared to their peers

Boost your marketing efforts 
Another path to organic growth is to loosen the purse strings on your marketing budget. It's not uncommon for a firm to spend less than 3% of its revenue on marketing and business development, according to Dimensional's 2021 Global Advisor Study. The underlying assumptions are that firms are more interested in short-term profits than long-term growth and are hesitant to direct resources to unfamiliar territory. 

Compared to the immediate gratification of a client referral or large deposit from an existing client, the payoff from an inbound lead-generation strategy can seem delayed and ambiguous. But for a firm truly committed to sustained organic growth, it wouldn't be outrageous to put more than 15% of its revenue toward marketing and business development (including staff and promotional spend). If the thought of slashing your profit margin by 10% raises your blood pressure, consider a gradual approach that starts with the following steps:

READ MORE: Should RIAs consider selling to family offices instead of private equity?

Assign one person at your firm to be the owner of demand generation. This person could be you, if you happen to be marketing-inclined and are willing to offload your client work. But more likely you'll want to hire someone with experience in marketing automation, social media, content production and web design. The marketing team may expand with various support roles, but the idea is to have one person you can hold entirely accountable for putting new, inbound appointments on the calendar.

Be generous with free advice, free content and free tools to remove friction from your marketing funnel. It always pays to be generous with the education offered through weekly podcasts, monthly webinars, CE dinner events, eGuides and complimentary assessments. While the reluctance to "give stuff away for free" or "share your IP" is understandable, free offerings give you more credibility, build trust and give prospects a preview of what it's like to work with you.

Growth story
As Liz Koehler, head of BlackRock's U.S. Wealth Advisor Insights Team, noted in the RIA Deal Room Report "Back to the Future 2023": "As advisors evaluate their options and any possible implications in becoming active in M&A, it is paramount that they take the time, alongside their team, to first get their own house in order by having a clear value and growth story."

As you take measures to develop your growth plan, be sure to document your progress at quarterly intervals. Not only will buyers want to see your track record, they will also be impressed by your level of organization and attention to your growth metrics (instilling more confidence as they evaluate your firm as a potential partner). 

Along the way, by tracking your organic growth metrics you'll be able to quickly identify issues and make course corrections to keep your firm moving in the right direction. 

Ultimately, as you look ahead to that day of negotiation, the best-case scenario is one where you'll be simultaneously happy to keep growing your RIA and willing to sell if the price is right. That position of strength alone could be worth a few points on your EBITDA multiple.

If you have a book of consistent depositors and a low-friction marketing engine that keeps new clients coming through the door, your option to stay the course will remain an attractive one — which means the buyer might have to sharpen their pencil.